While in secured loans collaterals are pledged, unsecured loans are those which are given on the basis of borrower's creditworthiness.
Loans play a crucial role in meeting shortage of funds when you want to buy a house, car or for any kind of immediate personal need. You take a loan to fund your education or a new business venture. Therefore, it is important to understand the two kinds of loan – secured and unsecured loans and the differences between the two. While in secured loans collaterals are pledged, unsecured loans are those which are given on the basis of borrower’s creditworthiness.
Both types of loans serve different purposes and are different in terms of tenure, interest, eligibility etc. Some of the secured loan products are home loan, loan against property, loan against fixed deposits, loan against gold jewellery and car loans. Personal loan and credit cards are types of unsecured loans.
So, how will you decide which loan suits your requirement? It will depend on your needs in terms of tenure, purpose, interest and loan size.
Points to remember while taking Secured or Unsecured loans
As stated above, you can opt for an unsecured loan if your CIBIL score is sufficient. This means that you should keep your appetite low for unsecured loan by not applying for too many of them. Although unsecured loans are easily available, it is best to exercise restraint. Repayment of unsecured loan in a disciplined manner would help you improve your credit score. It is better to review your loan balance amount from time to time.
It is also important to note that while taking an unsecured loan, do not pledge a collateral, which has higher value than what bank needs. You can go for pledging two or more smaller assets, which match the value of your loan.
You can go for a secured loan provided you have sufficient liquidity, collateral and asset backup as it would cost you an interest rate which is lower. For example, you can take a loan against your fixed deposit at 1% to 2% spread over the FD interest rate.
Banks usually seek collaterals for long-term loans. For short-term loans, which is between six months and two years, banks consider your repayment capacity on the basis of your income and offer a personal loan without asking for any collaterals. Personal loans have a comparatively higher interest rate, and there could be pre-payment penalties as well.
Those bank account holders who have a good transaction history and CIBIL score could smoothly get unsecured loan from banks.
Let us take a look at some of the features of both the secured and unsecured loans
Interest rate: Interest rate is low as collaterals are pledged and the risk is low
Availability: Easily Available
Tenure: Short to Long term
Loan size: The loan amount is relatively higher and is determined based on the availability of collaterals
Processing time: Verification steps make it longer
Rejection chances: Low, depending on the loan requirement and the availability of collaterals to pledge against the loan.
Interest Rate: High interest rate. Interest charged based on the tenure and size of loan etc
Availability: Good credit score and sound banking relationship required
Tenure: Available for short to medium term
Loan size: The amount of loan offered depends on the income and credit score of the borrower. The cap is relatively lower.
Processing time: Loan disbursal is quicker due to lesser paperwork.
Rejection chances: High, depending on the credit score and the income level.
(The writer is CEO, BankBazaar.com)